Category: Market Action

It didn’t take long for the Americans to start blaming the messenger:

On one hand, there is a case to be made that the madness of the right has made America a fundamentally unsound nation. And yes, it is the madness of the right: if not for the extremism of anti-tax Republicans, we would have no trouble reaching an agreement that would ensure long-run solvency.

On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.

More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation.

I have a question for Mr. Krugman: If S&P had taken this action 10 years ago, would you have gotten this angry? Or would you have laughed?

When you howl, you’re hit!

As always, I will emphasize that I have no faith in the infallibility of credit rating agencies. But I will also point out that they have a track record that is a damn sight better than their vociferous critics (those who have actually done credit analysis, those who have actually plunked money or reputation down on the table due to their own credit analysis, will often criticize – but not so vociferously. Why not? Because once you do the work and see how it turned out, you get a better understanding of how damn hard it is).

The greatest value of credit rating agencies is that they are highly visible and form a touchstone for investors and issuers alike. Lots of people have been decrying US fiscal policies for some time. It took a downgrade from S&P to attract a decent amount of interest.

I continue to believe that the US will not get serious about its fiscal problems until the day when the President gets a call from Treasury saying they’re not sure if they can sell the bonds. Hopefully, it will be a Democrat president who takes the call – he’ll have more political room to cut spending. That’s what it took in Canada … that’s what it took in Greece … that’s what it took in Ireland … Portugal … Italy …

Here’s a more sensible idea:

There is a lot of anger at the moment in the US over the embarrassment of the downgrade, as well as shock. I’m most amused by the shock, to tell the truth. S&P didn’t say anything yesterday that was not common knowledge and common sense.
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But that fiscal structure far predates Barack Obama, both as President and as human being, and Congresses and White Houses of both parties have done little to address the real problems in Medicare, Medicaid, and Social Security.
Why? Because as soon as people try to do so, demagogues accuse them of wanting to push Grandma over a cliff. Voters respond by punishing the reformers and rewarding the demagogues. If we collectively want to blame someone, we collectively should be looking in a mirror.

But the politicians and their minions are, as I predicted on Friday, focussing on the arithmetical error as the basis for their arguments. Here’s what John Bellows, Acting Assistant Secretary for Economic Policy, wrote in a post titled Just the Facts: S&P’s $2 Trillion Mistake:

In a document provided to Treasury on Friday afternoon, Standard and Poor’s (S&P) presented a judgment about the credit rating of the U.S. that was based on a $2 trillion mistake. After Treasury pointed out this error – a basic math error of significant consequence – S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.
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In fact, S&P’s $2 trillion mistake led to a very misleading picture of debt sustainability – the foundation for their initial judgment. This mistake undermined the economic justification for S&P’s credit rating decision. Yet after acknowledging their mistake, S&P simply removed a prominent discussion of the economic justification from their document.
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S&P acknowledged this error – in private conversations with Treasury on Friday afternoon and then publicly early Saturday morning. In the interim, they chose to issue a downgrade of the US credit rating.

Independent of this error, there is no justifiable rationale for downgrading the debt of the United States. There are millions of investors around the globe that trade Treasury securities. They assess our creditworthiness every minute of every day, and their collective judgment is that the U.S. has the means and political will to make good on its obligations. The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raise fundamental questions about the credibility and integrity of S&P’s ratings action.

I remain true to my conviction that the most sensible words ever spoken by a Canadian politician – or any politician, anywhere, confronted with a debt crisis – were spoken by Jean Chretien. Someday I’ll find the reference and the exact phrase, but it was something like … “We aren’t doing this because this is what the bond market thinks we should do! We are doing it because we don’t want to care what the bond market thinks!”

Dealbreaker comments on one of the interesting knock-on effects of the downgrade:

In other words if you own Microsoft bonds (1) you don’t own Microsoft bonds, DTC does – you just have a certificate from DTC saying that they own those bonds on your behalf, and (2) Microsoft takes no responsibility for DTC paying you any of the interest or principal that it pays DTC. So if DTC decides not to pass the money along to you, you’re out of luck.

This is not a real problem of course as there are a whole lot of systemic/legal/etc. safeguards in place to make sure that DTC doesn’t take its $34 billion in assets to Vegas. But according to S&P, DTC is now more likely to default than Microsoft is – which means that your likelihood of getting paid back on a Microsoft bond is lower than the likelihood that Microsoft will pay you back. (I know!)

Ah, the joys of a world where AA+ is the new AAA …

I am often criticized for not doing on-line banking. But there’s a reason:

When she learned TD Bank was to hold a fraud-prevention seminar on May 13, 2010, in Burlington, Vermont, she hopped on a plane and slipped into the meeting. During the morning presentation, when an expert in wire transactions was talking about ways that small businesses could protect themselves from the dangers posed by cybercriminals, McCarthy raised her hand.

Why wasn’t TD Bank doing a better job protecting its small- business clients, she asked. How had TD Bank allowed $164,000 to be wired out of her account even though she hardly every made wire transfers? As the speaker tried to respond, McCarthy kept peppering him with questions about his bank’s responsibilities to its clients.

Two bank representatives, including TD Bank’s head of corporate security and investigations, walked over to McCarthy’s table and suggested they continue the subject outside. McCarthy told the head of security it was good to meet him finally, since she’d been calling him for weeks following the robbery and had never gotten through.

Jennifer Morneau, a spokeswoman for TD Bank, confirmed that there was such an incident involving a “woman from Long Island” at one of its anti-fraud seminars, and didn’t have any further information.

Looks like Europe will start buying Spanish and Italian bonds:

The European Central Bank said it will “actively implement” its bond-purchase program, signaling it is ready to start buying Italian and Spanish securities to counter the sovereign debt crisis.

In a statement issued in the name of President Jean-Claude Trichet after an emergency teleconference meeting of policy makers, the Frankfurt-based ECB welcomed Italy and Spain’s efforts to reduce their budget deficits. It also called on all euro-area governments to follow through on the measures agreed at a July 21 summit, including allowing the European Financial Stability Facility to purchase bonds on the secondary market.

“It is on the basis of the above assessments that the ECB will actively implement its Securities Markets Program,” the central bank said. “This program has been designed to help restoring a better transmission of our monetary policy decisions — taking account of dysfunctional market segments — and therefore to ensure price stability in the euro area.”

There, you see? The reason Spanish and Italian bond yields are so high isn’t because they’re risky credits – it’s because the markets are dysfunctional.

The European crisis is causing a certain amount of capital flight, with bank depositors looking for the security of US Banks. There’s only one problem – the banks don’t want it:

Cash held by U.S. banks surged 8.4 percent to a record $981 billion during the week ending July 27, the Federal Reserve said in an Aug. 5 report. That’s more than triple the amount firms had in July 2008, before the collapse of Lehman Brothers Holdings Inc. almost froze bank-to-bank lending.

Even more money may be deposited with U.S. lenders if investors pull away from European banks amid concern the Greek debt crisis may spread to Italy or beyond, said Brian Smedley, a strategist at Bank of America Merrill Lynch in New York. Those funds may not be so welcome: With few opportunities to lend them out profitably, U.S. firms may have to slap fees on depositors to keep returns from eroding.
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Since late 2008, the Fed has been paying interest on deposits placed with the central bank, known as interest on excess reserves, or IOER. That rate is currently set at 25 basis points, or 0.25 percent.

At that rate, banks may struggle to profit from even non- interest-paying deposits, because the companies must pay premiums to the Federal Deposit Insurance Corp. when they route the money to the Fed. On April 1, the FDIC changed its methodology for assessing premiums, resulting in an increased cost for most large banks. Because a deposit at the Fed is technically an asset, taking the money may stretch banks’ capital-to-asset ratios, which are watched by regulators, Joseph Abate, a money-market analyst at Barclays Capital in New York, wrote in an Aug. 5 report.

“The higher deposit cost, the potential need for additional capital and the flight-prone nature of these balances clearly outweigh the 25-basis-point return from IOER that they would earn depositing the money at the Fed,” Abate wrote. Any reduction in IOER — a move Fed Chairman Ben S. Bernanke told Congress in July might be possible — may create a “serial round of deposit fees” since banks would try to “push cash from their balance sheets” like a game of “hot potato.”

It was an interesting day today:

The S&P 500 retreated 6.7 percent to 1,119.51 at 4 p.m. in New York. The gauge slumped 11 percent in three days, the most since November 2008, and fell to the lowest since September 2010. The Dow Jones Industrial Average slid 634.76 points, or 5.6 percent, to 10,809.85. The Russell 2000 Index of small companies slumped 8.9 percent, entering a so-called bear market, down 25 percent from its April 29 high.
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The downgrade extended a rout that had wiped out $1.94 trillion in market value from the country’s stocks amid concern the economic recovery is at risk. Global equities tumbled and European shares entered a bear market. The Stoxx Europe 600 Index has now fallen 21 percent from this year’s high on Feb. 17. The S&P 500 is down 18 percent since April 29.
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The Chicago Board Options Exchange Volatility Index, which measures the cost of using options as insurance against declines in the S&P 500, soared 46 percent to 46.80, the highest since March 2009.
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The KBW Bank Index of 24 stocks slumped 11 percent. Bank of America dropped 20 percent, the most in the S&P 500, to $6.53. American International Group Inc. (AIG), the bailed-out insurer, sued the largest U.S. lender by assets over $10 billion in losses on mortgage-bond investments.
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Equity indexes extended losses after S&P changed the outlook for Warren Buffett’s Berkshire Hathaway Inc. (BRK/A) to “negative” from “stable.” Berkshire Hathaway Class B shares slumped 6.4 percent to $66.66.

“Our view of these companies’ fundamental credit characteristics has not changed,” S&P said in a statement today as it cut the outlook on Omaha, Nebraska-based Berkshire. “Rather, the rating actions reflect the application of criteria and our view that the link between the ratings on these entities and the sovereign credit ratings on the U.S. could lead to a decline in the insurers’ financial strength.”

Not surprisingly, it was clobberin’ time for the Canadian preferred share market, with PerpetualDiscounts losing 1.94%, FixedResets off 1.30% and DeemedRetractibles down 1.74%. There was not a single winner in the lengthy volatility list – and when each of the three major indices is down more than the threshold for inclusion in the volatility list, you get a very extensive volatility list indeed! Volume was quite high, but block traders were, if anything, less active than usual.

Since the politicians won’t bail out Ireland and Portugal, the central bank is doing it:

European Central Bank President Jean- Claude Trichet said the ECB has resumed bond purchases and will offer banks more cash to stop the region’s debt crisis from engulfing Italy and Spain and hurting the economy.
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ECB purchases of Irish and Portuguese bonds during the press briefing haven’t stamped out investor concern on the 21- month crisis spreading to Italy and Spain, whose yields soared to euro-era highs this week. European officials are trying to put a firewall around Europe’s third and fourth-largest economies to avoid them being forced into seeking external aid.
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Italian and Spanish 10-year bonds declined, pushing the yields as high as 6.23 percent and 6.33 percent respectively. Irish and Portuguese bonds rose as people with knowledge of today’s transactions said the ECB bought those securities after being absent from the market for 18 weeks. That debt was at 10.4 percent and 11.3 percent as of 5 p.m. in London.

Gee, isn’t it great when a central bank takes on credit risk?

But don’t lose faith in Europe! It’s all America’s fault:

And Mr. Trichet pointed the finger at the U.S. debt ceiling showdown for stoking market tensions in Europe.

“It’s clear the world is intertwined,” he told reporters after the bank opted to leave its key interest unchanged at 1.5 per cent. “What happens in the U.S. influences the rest of the world.”

There are indications Italy is serious about austerity:

The Italian government, seeking to earn the confidence of investors who have driven its bond yields to euro-era highs, will speed up austerity measures and will target a balanced budget a year earlier than planned.

The country will adopt a balanced-budget amendment, liberalize its labor market, and speed asset sales, Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti said in a joint Rome press conference today.

While yields on Italian and Spanish debt fell today, borrowing costs have surged since a July 21 European Union summit aimed at heading off contagion from Europe’s debt crisis to the euro zone’s third- and fourth-largest economies. Italian 10-year bond yields are up 76 basis points since the summit, while Spanish yields are up 33 basis points.
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Berlusconi said the government now won’t wait until 2013-2014 to eliminate tax loopholes and deductions worth 25 billion euros ($36 billion), though he didn’t say when they would be enacted. He also said he agreed with French President Nicolas Sarkozy to hold a meeting of Group of Seven finance ministers within days.

Spanish borrowing costs are below those of Italy for the first time since May 2010 on speculation Italy’s higher debt load makes it less able to withstand contagion from the region’s fiscal crisis. The nation’s debt is set to reach 120 percent of gross domestic product this year, second highest in the euro region after Greece.

S&P downgraded USA:

The U.S. had its AAA credit rating downgraded for the first time by Standard & Poor’s, which slammed the nation’s political process and said lawmakers failed to cut spending enough to reduce record deficits.

S&P dropped the ranking one level to AA+, after warning on July 14 that it would reduce the rating in the absence of a “credible” plan to lower deficits even if the nation’s $14.3 trillion debt limit was lifted. The U.S. was awarded the top credit ranking by New York-based S&P in 1941. It kept the outlook at “negative.”
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S&P said it may lower the long-term rating to AA within the next two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” during the period result in higher general government debt.
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S&P also changed its assumption that the 2001 and 2003 tax cuts would expire by the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”

“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating,” S&P said.

The downgrade process was, apparently, enlivened by a $2-trillion arithmetical error that you can be sure the politicians will harp on (Treasury’s started already). The S&P release highlights:

• We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.
• We have also removed both the short- and long-term ratings from CreditWatch negative.The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
• More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
• The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.

The Fed has issued guidance to banks:

Earlier today, Standard & Poor’s rating agency lowered the long-term rating of the U.S. government and federal agencies from AAA to AA+. With regard to this action, the federal banking agencies are providing the following guidance to banks, savings associations, credit unions, and bank and savings and loan holding companies (collectively, banking organizations).

For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

That’s how Europe can solve its banking problems! Just allow loans-gone-bad to be risk-weighted at their original rates!

I remember the DBRS downgrade of Canada in Spring, 1994, which the ancients among us will remember as a horrible bear market for bonds, full of nervousness. The downgrade was announced at about 5pm; we were getting pricing data from two brokerages, one of which prepared their run prior to the announcment, the other after. Only a few minutes, but there were literally dollars of difference in the long bond prices! Bids just disappeared as the dealers went short in preparation for overnight selling.

Yellow Media’s sell-side analysts continue to follow the stock:

Canaccord Genuity believes the carnage isn’t over yet. In a new research report today, analyst Aravinda Galappatthige cut his price target to a mere 60 cents, a far cry from his previous guess of $2.75. Not surprisingly, he downgraded Yellow Media to a “sell” from a “hold.”

“The steep decline in our target is due to common equity at now only 20 per cent of the enterprise value of the company,” Mr. Galappatthige explained. “Consequently, even moderate cuts to earnings before interest, taxes, depreciation and amortization and free cash flow, which lowers enterprise value, have the potential to have a magnified impact on equity.”
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“Yellow Media is in the midst of transforming its business from a directory publisher to a broader, online-centric, marketing solutions company serving mainly small and medium enterprises. While we do expect to see some success for the company in this process, we believe print declines will hit double-digit rates starting fiscal 2011 and more than offset online growth, given that print currently makes up approximately 75 per cent of revenues. Moreover, if the print declines worsen – to 15-20 per cent levels, as we are seeing in most international markets, we believe Yellow Media’s EBITDA and FCF could be impacted significantly.”

CIBC World Markets Inc. analyst Robert Bek today also took a knife to his price estimate, slashing it to $1.25 from $5.50.

“Though the Band-Aid has been ripped off this story, we still believe investors should watch on the sidelines as an equity recovery is tenuous, at best,” he wrote. “Our (new price target) is probably half way to fair value, but downside risks are material, including the potential for a restructuring if conditions worsen.”

In the comments to the recent YLO post, newbiepref instructs me on a feature of the TSX website: Insider Trades by Symbol, through which I see that YLO (almost certainly YLO, but it could be some other insider) bought all four of its preferred share issues today. The total value was only $160,000 (about 2/3 of it in YLO.PR.A) but even so they’re taking these things off the balance sheet at about half-price, on average. Nice work if you can get it!

These are small quantities, to be sure, but it will be remembered that quantities are restricted under the terms of their Normal Course Issuer Bid:

In accordance with the rules of the Toronto Stock Exchange, the maximum numbers of securities that can be purchased on a daily basis by Yellow Media Inc. are 641,849 common shares, 5,248 first preferred shares, series 1, 3,134 first preferred shares, series 2, 3,068 first preferred shares, series 3 and 1,385 first preferred shares, series 5, subject to the block purchase exception

They hit the limits precisely – to the very share! – for three of the four issues; they were sloppy with YLO.PR.B and bought only 3,100 of the allowable 3,134. As discussed in the commented post, they’re not buying the common any more, probably because of bank loan covenants.

It was a weak day for the Canadian preferred share market, with PerpetualDiscounts down 4bp, FixedResets off 3bp and DeemedRetractibles losing 18bp. Good volatility; let’s hope things heat up a little more next week! Volume was average.

Here’s a sign of the times:

Bank of New York Mellon Corp., the world’s largest custody bank, said it will charge clients a 13 basis point fee for “extraordinarily high” cash deposits.

“We have seen a growing level of deposits on our balance sheet from clients seeking a safe haven in light of the global interest rate and credit environment,” the company said today in an e-mailed statement.

It’s not clear whether this means the net yield to clients will be negative. But negative yields are quite fashionable:

Money market rates, which surged during the debate to raise the federal borrowing cap, dropped below zero percent as Europe’s sovereign-debt crisis bolstered U.S. government securities’ appeal as the world’s safest assets.

Demand for short-term government debt instruments is rising as Treasury bills are expected to remain in short supply after the U.S. signaled yesterday it won’t increase sales of the securities even following lawmakers’ agreement to raise the debt ceiling.
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European Central Bank President Jean-Claude Trichet said today the ECB has resumed bond purchases and will offer banks more cash to stop the region’s sovereign-debt crisis from engulfing Italy and Spain.

One-month Treasury bill rates traded at zero percent today after earlier falling to negative 0.0102 percent. They closed yesterday at 0.0051 percent yesterday and reached 0.1825 percent on July 29, the highest since February 2009.

Equities were interesting today:

A global rout in equities drove the Standard & Poor’s 500 Index to its worst slump since February 2009, while two-year Treasury yields plunged to a record low amid concern the economy is weakening. The yen pared losses, recovering from the biggest drop versus the dollar since 2008 that was triggered by Japan selling its currency.

The S&P 500 tumbled 4.8 percent to 1,200.07 at 4 p.m. in New York with futures on the gauge slipping 0.2 percent as of 6:17 p.m. The S&P 500 has dropped 11 percent since July 22, the biggest loss over the same amount of time since March 2009. The MSCI All-Country World Index slid 4.1 percent as Brazil’s stocks slumped to a two-year low and Switzerland’s entered a bear market. Two-year yields declined as low as 0.25 percent. The yen sank 4.1 percent against the dollar before trimming its loss almost in half. Oil sank 5.8 percent to help the Thomson Reuters/Jefferies CRB Index of materials erase its 2011 gain.

The Canadian preferred share market was also affected, but not to nearly the same degree (unless you own YLO preferreds), as PerpetualDiscounts lost 17bp, FixedResets were down 10bp and DeemedRetractibles were off 10bp. Volatility was high, comprised entirely of losers. Volume was good.

PerpetualDiscounts now yield 5.44%, equivalent to 7.07% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.9% (!), so the pre-tax interest equivalent spread is now about 215bp, a sharp increase from the 185bp reported on July 29 as PerpetualDiscounts have remained stable while long corporate yields plummetted.

Dealbreaker has a surprisingly thoughtful piece on the US credit rating:

That’s probably the best way to interpret market reactions. Rates on the $10 trillion of publicly held Treasuries couldn’t be tighter, suggesting that there’s no real market worry about the U.S.’s ability to pay off its debts. But CDS notionals keep increasing (albeit in a still small and illiquid market) and CDS levels are wide of AA corporates because the U.S. is actually more likely to default than Colgate Palmolive is. Because it would not occur to anyone at Colgate Palmolive to just stop paying its debts. But we’re going to have to keep rasing the debt ceiling, and every time we do, half of Congress is going to say that they prefer to default.

The idiotic Federal Aviation Administration crisis is symptiomatic:

The U.S. House of Representatives and Senate finished voting on legislation this week and recessed for the month of August without extending the FAA’s funding authority, which expired at midnight July 22. That idled about 70,000 construction-related workers and furloughed 4,000 FAA employees. The FAA also is forgoing $28.6 million in aviation taxes each day the deadlock continues. That would add up to $1.3 billion by the time Congress resumes legislative business on Sept. 7.
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Transportation Secretary Ray LaHood said legislators should return to Washington and pass an extension without cutting subsidies for flights to 13 rural airports. The cuts were in a House-passed bill to extend the FAA’s authority through Sept. 16 that was introduced by Representative John Mica, the Florida Republican who chairs the transportation committee in that body.

Senate Majority Leader Harry Reid, a Nevada Democrat, said yesterday he was prepared to accept the House bill. Other Senate Democrats refused, said Adam Jentleson, a spokesman for Reid.

The FAA’s last multi-year funding bill expired in 2007. Congress has passed 20 limited extensions since then without adopting a new long-term authorization measure.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 21bp, FixedResets gaining 9bp and DeemedRetractibles up 14bp. Volatility was minimal. Volume was average.

Yellow Media reports on 11Q2 tomorrow before the opening, so YLO preferreds could have an interesting day!

Christophe Chamley, a professor of economics at Boston University, writes an interesting piece on Bloomberg about the Spanish default of 1575:

At that time of costly communications, periodic commercial fairs were essential events for the economic activity throughout Europe. Credit was rolled over from fair to fair by bankers, and lending agreements were renegotiated. With the Spanish commercial credit market frozen, the fairs couldn’t be held. Indeed, the main fair that was held twice a year at Medina del Campo was canceled. In short, the default caused a banking collapse, which led to a severe recession.

After two years, in November 1577, the cities caved, agreeing to a very large tax increase. The king resumed debt payments to the bankers. As the king explained in the settlement agreement, called Medio General, the bankers were joined in their demands “by the petition of the delegates of the cities with particular urgency about the same business.” In other words, the cities were begging the king to restore the business of trade. The fairs at Medina del Campo resumed late in the next year, but they had lost their preeminence forever.

It was a quiet day on the Canadian preferred share market, with PerpetualDiscounts up 1bp, FixedResets winning 3bp and DeemedRetractibles flat. Volatility was minimal. Volume was pathetic.

Moody’s put Spain on Review-Negative:

Spain faces a possible downgrade by Moody’s Investors Service as its regions struggle to cut budget deficits and last week’s Greek bailout increases the risk that bondholders will have to pay for further European rescues.

Moody’s is reviewing the nation’s Aa2 classification, the ratings company said in a statement today. A cut would probably be “limited to one notch,” Moody’s said. The euro fell. Spain has the same credit rating as Italy, which is also on review for downgrade at Moody’s.

The trouble with regulators, as a class, is their inability to think things through. Increased transparency in the public bond market has brought with it reduction of choice for public investors, as more deals are done on a private placement basis, and thinner markets for the ones that remain, as capital gets redeployed to more profitable areas. Another example of this is hedge fund regulation:

There’s a two-word explanation for closing what was once one of the world’s biggest hedge funds and consistently one of the best-performing — with returns of about 30 percent annually in its first 30 years: Dodd-Frank. The law requires hedge funds to register with the Securities and Exchange Commission and provide information about customers, employees and assets. By returning outsiders’ money, Soros Fund Management escapes that rule and the loss of privacy that goes with it.

“An unfortunate consequence of these new circumstances is that we will no longer be able to manage assets for anyone other than a family client as defined under the regulations,” the brothers wrote in a letter to investors.

Or maybe regulators do think things through – a regulator’s ideal world is one in which everybody holds only plain-vanilla investments, nobody every complains and regulators are never subjected to criticism, informed or otherwise.

I would love to offer Malachite Aggressive Preferred Fund to the general public … but the process isn’t just expensive, it’s stupid expensive. To make such an idea work, I would have to convert my firm into just another marketting and distribution firm, with investment management tacked on as an unfortunate operating expense to be minimized.

There has been lots of noise about the City of Toronto cost-cutting programme … the problem as I see it is not so much that the City is doing things it doesn’t need to do (although there’s plenty of that) as it is that it grossly overpays for what it does. Take librarians, for example. CUPE BC claims that Toronto librarians make almost $35/hr – and that report was dated June, 2007! Add pension and benefits to that and I’ll bet there’s not much change from $100,000 annually. My girlfriend tells me that when she goes to the library and uses the scanner to check out books, there are generally three – count ’em, three – librarians watching her do it.

YLO closed the Trader Corp. deal yesterday, but it didn’t do them much good on the market as three of their four preferreds were down significantly on the day (bid/bid) – the exception was the short-term retractible, YLO.PR.A.

These issues did horribly on the month, occupying four of the bottom six positions on the total returns ranking of the HIMIPref™ universe: only YLD.PR.B (worst) and BBD.PR.D (fifth worst) managed to break the hegemony. Total returns for the YLO prefs ranged from -6.4% (YLO.PR.A) to -18.4% (YLO.PR.D).

The Canadian preferred share market closed the month on a mixed note,with PerpetualDiscounts down 2bp, FixedResets down 2bp and DeemedRetractibles gaining 7bp. Volatility was low. Volume was … pretty close to non-existent!

PerpetualDiscounts now yield 5.44%, equivalent to 7.07% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 5.1% (maybe a little under) (!) so the pre-tax interest-equivalent spread is now about 200bp, a widening from the 185bp reported on July 27 as the two yields have moved in opposite directions over the past two days.

And that’s it for another month!

According to the chatterati, credit rating agencies are heroes this week:

At a House subcommittee hearing yesterday, U.S. financial regulators acknowledged that the rating companies lately have been doing a better job. Alarmed by Greece’s unsustainable borrowing, the companies have slashed Greek debt to below investment grade. Troubles in Ireland, Portugal and Spain aren’t as severe, but those countries are under appropriately close scrutiny by rating services. Even the U.S. has been tagged for a downgrade if it can’t sort out its debt-ceiling and spending problems — and maybe even if it does.

It was a quiet, slightly negative day for the Canadian preferred share market, with PerpetualDiscounts up 2bp, FixedResets losing 6bp and DeemedRetractibles down 3bp. Big volume continued for BNS.PR.Z, but was otherwise volume was only average.

The Bank of America takes wealth destruction seriously:

Bank of America Corp. (BAC), faced with a glut of foreclosed and abandoned houses it can’t sell, has a new tool to get rid of the most decrepit ones: a bulldozer.

The biggest U.S. mortgage servicer will donate 100 foreclosed houses in the Cleveland area and in some cases contribute to their demolition in partnership with a local agency that manages blighted property. The bank has similar plans in Detroit and Chicago, with more cities to come, and Wells Fargo & Co. (WFC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and Fannie Mae are conducting or considering their own programs.
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The lender will pay as much as $7,500 for demolition or $3,500 in areas eligible to receive funds through the federal Neighborhood Stabilization Program. Uses for the land include development, open space and urban farming, according to the statement

Speaking of wealth destruction, S&P downgraded Greece:

Greece will partially default on its debt once European officials push through a plan that will see bondholders foot part of the bill of a second bailout agreed to last week in Brussels, Standard & Poor’s said.

The rating company also cut its ranking for Greece to CC, two steps above default, from CCC, according to a statement published in London today. The outlook on the debt is negative.

“The proposed restructuring of Greek government debt would amount to a selective default under our rating methodology,” S&P said. “We view the proposed restructuring as a ‘distressed exchange’ because, based on public statements by European policy makers, it is likely to result in losses for commercial creditors.”

But stupid people can relax – the authorities are taking steps to ensure that nobody will ever lose money in the PPN market:

These are a way for banks to get cheap funding by packaging an unsecured debt security with an equity/credit/commodity/whatever derivative and selling it to customers who don’t have ISDAs or otherwise aren’t down with OTC derivatives. They’re called “principal protected” because even if the linked index goes down, you still get all your money back (albeit at zero yield). But that only happens if the issuer doesn’t go bankrupt – if they go bankrupt, you’re hosed just like other noteholders.

Which, duh, or so we thought. The notes after all said that they were Lehman’s unsecured obligations and that “an investment in the Notes will be subject to the credit risk of Lehman Brothers Holdings Inc, and the actual and perceived creditworthiness of Lehman Brothers Holdings Inc. may affect the market value of the Notes.” But that wasn’t enough for these plaintiffs, or for the judge, who is going to let the structured notes claims go to trial:
…
So the advice to structured notes desks is (1) put everything on the first page and (2) don’t assume that your customers are “careful and intelligent readers.”

Canadians, on the other hand, are indeed “careful and intelligent readers.”. I proved this on January 5:

Click for Big

In the States, though the SEC must be vigilant:

Among other things, the staff observed that broker-dealers might have:

• recommended unsuitable structured securities products to retail investors;
• traded at prices disadvantageous to retail investors;
• omitted material facts about structured securities products offered to retail investors;
• engaged in questionable sales practices with customers.

YLO will release 11Q2 results on August 4.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts losing 6bp, FixedResets off 2bp and DeemedRetractibles up 10bp. Volatility was muted (but all negative); volume was average, but with massive volume in BNS.PR.Z (which had a “last” quote with a gigantic spread) on the back of some very nice tickets by RBC.

PerpetualDiscounts now yield 5.38%, equivalent to 6.99% interest at the standard equivalency factor of 1.3x. Long corporates now yield 5.15% (!!) so the pre-tax interest-equivalent spread is now about 185bp, a tightening from the 200bp reported on July 20 as the PerpetualDiscounts played catch-up to the prior downward move in bond yields.

The SEC has invented more paperwork:

The rule contains the following requirements:

Filing a Form: Traders who engage in a substantial level of trading activity will be required to identify themselves to the SEC by filing a form, Form 13H, with the Commission. A “large trader” will be defined as a person whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month.

The rule provides guidance on certain types of transactions that can be excluded for purposes of calculating trading levels.

Getting an Identification Number: After it files Form 13H to register with the Commission, the SEC will then assign each large trader a unique large trader identification number (LTID), which will allow the agency to efficiently identify and analyze trading activity by the large trader. A large trader will be required to disclose to its broker-dealers its LTID and highlight all of the accounts at the broker-dealer through which the large trader trades.

Recordkeeping, Reporting, and Monitoring: The rule requires broker-dealers to maintain and report data that is largely identical to the information covered by the Commission’s Electronic Blue Sheets (EBS) system – the system the SEC currently uses to collect transaction data from broker-dealers. The only additional items that broker-dealers will be required to maintain and report are the LTID and the time a transaction occurs. Accordingly, the rule leverages the existing EBS system, with modifications, to accommodate the specific requirements of the new rule. In addition, the rule requires broker-dealers to monitor whether their customers meet the threshold levels that define a “large trader” (based on transactions handled at the broker-dealer) in order to encourage compliance by their customers with the requirement to identify themselves as large traders to the SEC.

Ready Access to Data: The rule requires transaction data to be available for reporting on the morning after the day the transactions were effected. When the SEC requests data from broker-dealers, it would not under normal circumstances require responses earlier than the opening of business on the day after it makes its request. Prompt access to this data will assist the SEC in reconstructing market activity and performing other trading analyses, and also will assist in investigations of manipulative, abusive, and other illegal trading activity.

The Ontario Ministry of Pretending to Do Things So We Can All Feel Good has:

released comprehensive teacher guidelines that identify places in the Grade 4 through 12 curriculum where financial literacy can be inserted into classes as varied as mathematics, computer science and native studies.
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Ontario, for example, suggests that in high school, “when studying classical civilizations, students could address aspects of trade, economics and use of money in ancient times,” according to the new teacher guidelines.

It was another positive day on the Canadian preferred share market, with PerpetualDiscounts winning 20bp, FixedResets up 2bp and DeemedRetractibles gaining 5bp. Volatility was low; volume was below average.

This is getting monotonous:

Greece’s sovereign credit rating was cut three steps by Moody’s Investors Service, which said the European Union’s financing package for the debt-laden nation implies “substantial economic losses” for private creditors.

Greece’s long-term foreign currency debt was downgraded to Ca from Caa1, the ratings company said in a statement in London today. Moody’s assigned a developing outlook to the ratings and said it will re-assess the credit risk profile of any outstanding or new securities issued by the Greek government after Greece’s debt exchange has been completed.

It occurs to me … one way that the Greek government hid debt was to enter into currency swaps with a present value far different from zero at trade-time. This was not just allowable under the rules at that time, but even encouraged and everybody knew they were doing it; this made it a little harder for the politicians to say it was all the brokers’ (Goldman Sachs’) fault, but somehow they managed.

I haven’t seen anything about these things for a while. Could it be possible that lenders through a swap facility will get off scot-free?

Who wants to take responsibility for this bond market effect?

A cut in the U.S. government’s AAA grade could force investors to sell asset-backed securities tied to student loans, causing spreads to widen “significantly,” according to Citigroup Inc.

“A ratings downgrade would be a significant blow” to the $250 billion government-guaranteed sector, Citigroup analysts led by Mary Kane said in a July 22 report. “The likelihood of forced selling is elevated.”

Citigroup sees a 50 percent chance of a ratings cut this year as the U.S. struggles to reduce its long-term debt. Many investors buy student-loan securities specifically because they’re so highly rated and a U.S. government credit risk, according to analysts at the New York-based lender. Money managers with rating-based guidelines would be forced to sell into a sinking market, affecting the sector more than other asset-backed debt tied to consumers, commercial mortgages and corporate loans, they wrote.

The situation worries me. I don’t think there’s any imminent danger, and I’ve written about this before … but remember the last days of the Roman Republic. You had two parties: the “good men” and the “populists”, nominally representing basically the old traditional oligarchy and the new guys looking in, respectively. Their main political purpose was to ensure that the other party couldn’t do anything – so little got done and everybody got frustrated and angry. Then along came Julius Caesar: smart, ambitious and ruthless, who staged a coup. All the US needs is another two decades or so of log-jam, and I’ll start taking bets.

S&P revised its outlook on BAM:

• We are revising our outlook on Brookfield Asset Management to stable from negative.
• At the same time, we are affirming our ratings on the company, including our ‘A-‘ corporate credit and ‘A-2’ short-term ratings.
• We base the outlook revision on the improved operating performance and outlook in Brookfield’s operating subsidiaries. It also reflects the
  company’s continued ability to execute its asset management strategy by attracting external investment capital, while maintaining company-level cash flow coverage measures in line with our expectation for the ratings.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 19bp, FixedResets up 1bp and DeemedRetractibles gaining 17bp. Volatility was minimal; volume was low.